Valuation of firms in mergers and acquisition

This document contains a detailed question and answer in relation to the three main methods of valuing firms in mergers and acquisitions. The three main methods include: Price per earnings ratio valuation, Dividend growth valuation and the DCF valuation.

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Valuation of firms in Mergers & Acquisitions. Question 1 Tyson PLC. has distributable earnings of £145m, a weighted average cost of capital of
9% and a P/E ratio of 20.4 times. It is in the process of taking over Bruno PLC whose
financial details are as follows: Bruno PLC : Key financial data
Profit before interest and tax
£89.00m
Interest paid
£14.20m
Corporate tax
£22.44m
Distributable earnings
£52.36m
Current dividend
15p
Last 4 years’ dividends
10.7p, 11.5p, 13.1p, 14.2p
Earnings per share (EPS)
14.7p
Price / Earnings ratio
17.55 times
Market price of ordinary shares
£2.58
Equity Beta
1.42
Replacement cost of non-current assets
£420m
Disposal value of non-current assets
£368m
Bruno PLC financial position statement
£m
£m
Non-current assets
385
Current assets
82
Total assets
467

Equity Finance:
Ordinary shares (nominal value 50p)
178
Reserves
27
205
Long-term liabilities:
6% bonds (redemption after 12 years)
188
Current liabilities
74
Total liabilities
467

Tyson PLC expects to maintain an annual increase in distributable earnings of 4% due
to anticipated synergy as a result of the takeover. The company will also be able to
sell surplus non-current assets for £85m in three years’ time. The current estimates of
cash flows of Bruno PLC.is £46m, but these are expected to grow at an annual rate of
5% in future years. The risk-free rate of return is 3.5% and the equity risk premium is
7%. Companies in the same sector as Bruno PLC have an average price / earnings
ratio of 18.2 times and a weighted average cost of capital of 10%. Required:
Calculate the value of Bruno PLC using the following valuation methods: a) Stock Market Valuation.
b) Price Earnings Ratio Valuation.
c) Dividend Growth Valuation.
d) DCF Valuation (Using Tyson’s WACC)
e) Using available resources (book, internet) calculate the following ratios:
 Stock market valuation
 Net Asset Value (use book value figures)
 Net Realisable Value (use book value figures)
 Net Replacement Value (use book value figures)
 Earnings Yield (Excluding and Including Growth)

Solution
Price-Earnings Ratio Valuation
Value of Bruno PLC using target firm P/E ratio
= £52.36m x 17.55
= £918.92m
Value of Bruno PLC using acquirer (Tyson’s) P/E ratio
= £52.36m x 20.4
= £1,068.14m
Value of Bruno PLC using a weighted average
= (17.55 x 52.36) + (20.4 x 145)
(145 + 52.36)
= 19.64 times
Therefore value of Bruno PLC
= £52.36m x 19.64
= £1,028.35m
Dividend Growth Model

g = [15/10.7] ^ 0.25 -1
= 8.81%

Cost of Equity using CAPM:
= 3.5 + [ 1.42 x (10.5 – 3.5)]
= 13.44%

Total Dividend:
= 0.15 x 356m
= £53.4m

Value:
= (£53.4 m x 1.0881)
(0.1344 – 0.0881)
= £1,254.96m
DCF Valuation (using Tyson’s WACC)
 Current cash flow
= £46m
 Cash flow growth
= 5%
 WACC of acquirer
= 9%
 Surplus assets sold in 3 years = £85m
= (46 x 1.05) + (85/1.09 )
(0.09 – 0.05)
= £1,273.14 m
Stock Market Valuation
Number of Shares x Market Value per Share
= (178m / 0.5) x £2.58
= £918.48m

NAV (Book Value)
Non-Current Assets + Net Current Assets – Long-Term Debt
= £385m + £8m - £188m
= £205m

NAV (Net Realisable Value)
Disposal Value of Non-Current Assets + Net Current Assets – Long-Term Debt
= £368m + £8m - £188m
= £188m
NAV (Replacement Value)
= £420m + £8m - £188m
= £240m
Earnings Yield Value (Excluding Growth)
Earnings Yield =
EPS
Market value per share
= 14.7 p
258 p